Sri Lankan rupee to fall further this year

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The Sri Lankan rupee is anticipated to fall more this year. The central bank of Sri Lanka will not protect the rupee at the cost of external reserves. The rupee depreciated 2.3 percent during the first six months of 2017, largely at the expense of external reserves. Sri Lanka expects a further 2-3 percent depreciation given the government’s borrowing needs and a rising fuel import bill. The rupee depreciated 4 percent in 2016 due to increased imports, continued foreign debt service payments and outflows from government securities following the US Fed hike.

The receipt of $1.5 billion sovereign bond sales and a $450 million syndicated loan have eased pressure on the rupee recently. The central bank governor recently said that the Central Bank will continue to buy dollars to build reserves; the brokers said they expect the impact to be minimal.

External reserves had weakened in an attempt to defend the currency, having fallen to $5 billion in April 2017. Lankan rupee reached an all time high of 153.80 in October of 2017 and a record low of 95.60 in December of 2003.

Analysis of merchandise imports and exports data of Sri Lanka reveals that the trade deficit (import export gap) has widened over the years. The deficit had in fact doubled since 2007. Despite a number of initiatives taken by the successive governments, the country has failed to increase its exports significantly.

Since 2007, exports have grown a mere 4.1 percent ($ 2.9 billion) while non-oil imports have grown at a faster rate of 8 percent ($ 7.5 billion). The new government elected in early 2015 has emphasized the need to follow a growth model driven by exports. The government plans to develop special economic zones (SEZ) around the already-existing infrastructure as well as plan future infrastructure projects to make those investments commercially viable. To achieve a growth driven by exports, the Sri Lanka needs to strengthen its competitiveness in the international market.

A competitive currency is a critical success factor for the export competitiveness of the country. The central bank has allowed exchange rate to depreciate at the time of economic crisis in the past. The budget 2012 proposed to devalue the exchange rate by 3 percent, by passing the mandate of the Central Bank of Sri Lanka.

Indian Rupee (INR), the currency of largest trading partner, depreciated by 14 percent against United States Dollars (USD) during the same period.

The general public is perturbed by the exchange rate depreciation experienced in Sri Lanka since the assumption of the new government in January 2015.

For the purpose of comparison, it is worth to note that Indian Rupee (INR) has depreciated 42 percent against USD since 2010 while Lankan Rupee (LKR) experienced depreciation of 28 percent during the same period.

This comparison with Indian Rupee (INR) is important as the largest trading partner of the country.

Due to the economic slowdown in major export destinations, primarily the United States and Europe, exporters face severe competition and could possibly lose market share.

The GDP growth, driven by the exports cannot be achieved without maintaining competitive exchange rate.

In theory, depreciation of a local currency encourages exports while curbing expensive imports. If Sri Lankan Rupee (LKR) didn’t adjust appropriately in comparison to its competitors, competitiveness in the international markets would be seriously crumbled.

One of the key concerns of the depreciation of Sri Lankan Rupee is imported inflation as many essential goods including fuel, cereal and large number of food items are imported into the country.

Sri Lankan rupee depreciated nearly 10 percent against the USD during 2015. The latest estimate for the consumer price inflation in the country as measured by Colombo Consumer Price Index (CCPI) is 4.8 percent (May 2016, year on year basis).

The inflation in the food category is 5.6 percent while the non-food category has increased by a lower rate of 4.2 percent. Despite widespread criticism, the recent depreciation of LKR should be viewed as a necessity from the analyst perspective. It could be attributed to the appreciation of USD against all currencies in the emerging markets, rather than standalone weakness of LKR or the underlying economy.

The fear of high imported inflation is insignificant at this environment as the international commodity prices have fallen significantly.

The depreciation of LKR has helped Sri Lankan exporters to remain competitive in tough global environment as indicated by real value of the currency.

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